Exemptions in Chapter 7 Bankruptcy

By , Attorney · University of the Pacific McGeorge School of Law

When filing for Chapter 7 or the "liquidation" bankruptcy, most people keep all of their property. You only lose property in Chapter 7 bankruptcy that you can't protect with a bankruptcy exemption.

If you're not familiar with bankruptcy exemptions yet, they're laws that let you keep essential property from creditors. For instance, creditors can't take your clothing, dishes, couch, or any other household item worth less than approximately $700 in most instances, although the specifics vary by state. Exemption laws protect those items, and more, from creditors both in and out of Chapter 7 bankruptcy.

But bankruptcy exemptions usually don't protect luxury items or assets with a lot of equity, so you could lose a boat, an expensive car, or even your home in Chapter 7. Whether bankruptcy exemptions will protect everything you own will depend on:

  • what you own
  • how much your stuff is worth, and
  • whether you can use the state or federal bankruptcy exemptions to protect your belongings.

Once you understand how bankruptcy exemptions work in Chapter 7, try our 10-question bankruptcy quiz. It will help you decide whether to file Chapter 7 yourself or hire a bankruptcy lawyer.

How to Use Exemptions in Chapter 7 Bankruptcy

When you file a Chapter 7 bankruptcy, the bankruptcy court appoints a bankruptcy trustee to sell your "nonexempt" assets or those things not protected by a bankruptcy exemption to pay your creditors.

However, filing for bankruptcy doesn't mean that you have to give up all of your property. Bankruptcy exemptions let you keep enough to give you a fresh start after the bankruptcy.

In bankruptcy, the Chapter 7 trustee can't sell an asset you can protect with an exemption. Keeping property in Chapter 7 bankruptcy will depend on the assets' value and the exemptions you can claim. Because of exemptions, most Chapter 7 filers keep all or most of their property.

How Much Property Can I Keep Using Exemptions in Chapter 7 Bankruptcy?

It will depend on the state in which you live. Each state has a set of exemptions, and most states require filers to use the state exemptions. However, some states let you choose either the state exemption system or the federal exemption scheme.

The federal system and most states allow you to keep a certain amount of equity in your house and your personal property, such as a car, many retirement accounts, and some wages, although relatively few states allow you to exempt much cash. Also, no matter where you live, your household goods and clothing are usually exempt unless they're unusually valuable.

You'll find state-specific amounts in Bankruptcy Exemptions by State.

What Is the Chapter 7 Bankruptcy Estate?

All of the property you own when you file for bankruptcy, except for most pensions and educational trusts, become part of what is known as the bankruptcy estate when you file for bankruptcy. For instance, the following assets will be part of your bankruptcy estate:

  • property in your possession
  • property in someone else's possession (such as an item you've loaned to a friend)
  • property you've recently given away
  • property you haven't yet received but are entitled to
  • proceeds from your property (such as rental income or dividends)
  • certain assets you receive within 180 days after filing (for example, an inheritance or lottery winnings), and
  • your share of marital property.

The bankruptcy trustee will assume control of the property in the bankruptcy estate throughout your case. What will happen to it in Chapter 7 bankruptcy will depend on whether you can protect it with an exemption.

How Do Property Exemptions Work In Chapter 7 Bankruptcy?

When you complete your bankruptcy paperwork, you'll list all of your property and any exemption that you can claim for each item. If the exemption covers the property entirely, you'll be able to keep it. If an exemption doesn't cover an item, the trustee will sell it and use the money to pay your creditors.

But sometimes, the situation can be more complicated. The exemption might partially cover the equity in the property. Or, you could have secured debt, such as a car payment or mortgage. In that case, the creditor's lien on the property ensures that the creditor gets paid first.

Here's how it works.

Suppose your car is worth $10,000, and your state allows you to exempt $5,000 in vehicle equity. Your outstanding car loan is $5,000. The trustee must pay the lender $5,000, leaving equity of $5,000. Because the bankruptcy exemption would protect all vehicle equity, the bankruptcy trustee would not sell the car.

If, however, your state only allows a $2,000 car exemption, then the trustee could sell your car and do the following with the proceeds:

  • pay the lender $5,000
  • pay you the $2,000 exemption amount
  • pay sales fees and costs out of the remaining $3,000, and
  • distribute any remainder to other creditors.

If the exemption scheme you're using has a wildcard exemption—an exemption you can apply to any property—you can use it in addition to the motor vehicle exemption that's specifically for protecting vehicle equity.

For a more detailed explanation, read about discharging a car loan in bankruptcy—you'll learn what will happen to the car.

When the Chapter 7 Trustee Abandons Property You Couldn't Exempt

Even if you can't entirely exempt an asset, the trustee might still choose to abandon it (decide not to take it) if liquidating it won't net a worthwhile payment to creditors. This usually happens when the property value is slightly higher than the exemption amount after considering sales costs. If the trustee abandons the property, you get to keep it.

Buying Property Not Covered by an Exemption From the Bankruptcy Estate

If you can't exempt property that you'd like to keep, the bankruptcy trustee might agree to allow you to purchase it at a discount (the asset's value minus the costs and fees related to the sale). You'll need to demonstrate that you're using funds that aren't a part of the bankruptcy estate, such as post-filing wages or a loan from a family member or friend.

Need More Bankruptcy Help?

Did you know Nolo has been making the law easy for over fifty years? It's true—and we want to make sure you find what you need. Below you'll find more articles that explain what bankruptcy is and how bankruptcy works. And don't forget that our bankruptcy homepage is the best place to start if you have other questions!

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We wholeheartedly encourage research and learning, but online articles can't address all bankruptcy issues or the facts of your case. The best way to protect your assets in bankruptcy is by hiring a local bankruptcy lawyer.

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